Donnerstag, März 03, 2011

How To Destroy An Economy...

If you want to destroy a functioning economy, remove the laws of supply and demand and watch everyone - everyone - flounder, trying to figure out where they should invest, who they should sell to, from whom they should buy. Some will guess right, others wrong, and at the end of the day you'll find that most have guessed wrong and the net benefit is strongly negative.

The single functioning mechanism that tells you everything you want to know about supply and demand is the price mechanism: left to its own devices (aka "The Invisible Hand", prices quickly develop that reflect true scarcity.

If you know the real price for a thing, you can also make the decision to transform that thing into something more valuable. Buy machines and you can turn inexpensive steel into gears and mechanical parts; if steel becomes more expensive, it makes sense to invest in order to use a scarce resource better.

This is fundamental, basic beginning Economics.

The German government, in all its wisdom - and given that it is a conservative government, there is actually some present, rather than what happens under socialist/green administrations - has come up with a real winner.

A tax on raw materials to force German companies to process raw materials better. See the Handelsblatt from today, first page.

Hmmm, you might say: what's so bad about that? Higher efficiencies are always a good thing, ceteris paribus, and if done right will add significantly to the bottom line.

The problem is that it will be the German government (or, more exactly, bureaucrats from the Environmental Agency) that decides which materials will be taxed and how much, rather than the market. That way lies madness.


Because German companies will be the ones investing their money, not the government. When the government gets it wrong - and it will, that is a fact of life - then German company investments will have been spent on the wrong thing, not because the company made the wrong decision, but because someone decided that it would be so.

That way lies madness. Seriously.

Prices are the only way to determine scarcity. If steel is heavily taxed, then other materials will be used; if all materials are heavily taxed, then companies will have to make decisions which materials to use based not on prices, but solely on technical grounds: that would, if anything, undermine the whole point of taxing materials at all.

It's not like German manufacturers are somehow incapable of producing goods with minimal usage of raw materials and the government has to give them a helping hand, as it were. If anything, they are better at it than most, if not almost all countries (I think that Japan is probably at the top there).

The argument of the Environmental Agency is that by forcing manufacturers to gain greater efficiencies now, their productive capacities will be that much more green and hence -  hence! - more profitable.

What they are not taking into account is the destructive effect of misallocated capital, that investing large sums for marginal improvements only makes sense when indeed market prices force this.

Simply deciding what the price for something will be - and taxes do this - removes the rule of supply and demand from the production figure, leaving everyone to flounder.

Given that no less than 20% of German GDP is manufacturing (relatively high: US shows 13%, France and the UK 12%!) is generated directly in manufacturing, raising taxes here is extremely counterproductive at best and downright stupid at worst.

Oh, and inflation: the European Central Bank will blow steam from its ears if this affects overall prices. You can't imagine, even for a second, that German companies will not pass on these taxes in the forum of price increases: or is the German Environmental Agency then going to determine as well selling prices too?

Destroying the almost literal magic of supply and demand in determining prices in the name of a chimerical whimsy that the government can better tell what resources need to be better utilized is one of the surer ways of destroying an industrialized economy.

I cannot imagine that this will actually pass into industrial policy under the current administration in Germany: Chancellor Merkel may have questionable taste in Defense Ministers, but she is not lacking in common sense otherwise.

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Sometimes, the good people prevail:

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